A credit-builder loan is designed to help people who have poor credit or who have little or no credit history build credit. A good score makes approval for credit cards and loans, at better rates, more likely.
Credit-builder loans do not require good credit for approval. They do require that you have enough income to make payments. The amount you borrow is held in a bank account while you make payments.
How does a credit builder loan work to better your score?
A credit-builder loan can help build credit if you pay on time (or no more than 30 days late). Payments are reported to the three major credit bureaus, Equifax, Experian and TransUnion.
Making on-time payments on a credit-builder loan can help you improve your credit profile because the payment information in your credit reports is weighted more heavily than any other factor in calculating your credit score.
See what powers your credit
Check your free credit score, get personalized insights. Weekly updates let you track your progress.
Credit-builder loans go by many names, such as “Fresh Start Loans” or “Starting Over Loans.” They’re not widely advertised and are generally offered by smaller financial institutions, such as credit unions and community banks.
Why do they do it? Financial institutions want to see you succeed. After all, if you become a customer, you’re more likely to make money for them in the future.
To make sure it doesn’t get burned on the loan, the lender will set strict limitations. Think of it as training wheels for credit.
How to get and manage a credit-builder loan
Find a credit-builder loan. Look for ones with a payment level you can comfortably afford. Stretching your budget to make a higher payment won’t impress lenders more. NerdWallet recommends choosing a low one and a term no longer than 24 months.
Apply for the loan. If you are approved, the money you borrow is deposited in a savings account that you typically can’t access until you have fully repaid the loan. This acts as a safety net for the lender that’s taking on risk if you have bad credit or no credit.
Make payments on time, every time. If you pay the loan as agreed, the financial institution promises to send a good report to the credit bureaus. But a payment more than 30 days late can seriously hurt your score.
Monitor your credit score. Personal finance websites such as NerdWallet offer free credit scores. NerdWallet’s scores are updated weekly. Don’t obsess over tiny movements, but look at the overall trend.
Collect your loan proceeds, plus any interest. At the end of the loan term, you get the money — and likely a better credit score.
Where to find a credit-builder loan
Credit unions or community banks: Finding a credit-builder loan can be tricky. One way to look is to search online for your state plus “credit builder loan.” You may find credit-builder loans available at nearby community banks…
Read More: What Is a Credit-Builder Loan?